Financial Markets Session 1 Olivier Brandouy
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Outline of Session 1 1. Financial Assets 2. Security markets
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(1) Micro and Macro Organiza@on
1 FINANCIAL ASSETS
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What is an Asset?
An asset is something that is owned by a business, ins@tu@on, partnership, or individual that has MONETARY VALUE.
Two Types of Assets Assets Physical assets
Financial assets (securi@es)
Key dis@nc@on: • Physical assets are income-‐genera@ng assets (producing goods or services). • Financial assets represent claims against the income generated by physical assets.
Physical Assets vs. Financial Assets: I • Divisibility Financial assets are divisible, whereas most physical assets are not. • Marketability (or Liquidity) Marketability is a characteris@c of financial assets that is not shared by physical assets. • Holding Period The planned holding period of financial assets can be much shorter than the corresponding holding period of most physical assets.
Physical Assets vs. Financial Assets: II Informa@on Availability Informa@on about financial assets is o[en more abundant, and less costly to obtain, than informa@on about physical assets.
Typology
Financial Assets Fixed Income
Stocks
Deriva@ves
Fixed Income Securi@es (Bonds) • When an investor buys a bond he/she becomes a creditor of the issuer. • Bonds usually pay fixed (some@mes floa@ng) periodic interest installments, called coupon payments. • At maturity the bond becomes due for payment and the par value is returned to the investor. • The price of a bond today is the present value of future coupons and par value.
Two Groups of Fixed Income Securi@es (Bonds) F.I. securi@es
Money market securi@es (maturity < 1 year)
Capital market securi@es (maturity > 1 year)
Money Market Securi8es Capital Market Securi8es Treasury bills Treasury notes Commercial paper Treasury bonds Bankers’ acceptances Federal agency bonds Nego@able cer@ficates of deposit Municipal bonds Repurchase agreements Corporate bonds Federal funds Mortgages and mortgage-‐backed Eurodollars
secu
Common Stocks • Represent part-‐ownership in a firm. • This ownership is residual in nature; that is, the common shareholders receive what is le[ over a[er all other claims on the firm have been sa@sfied (most noteworthy being bondholders’ claims). • These residual benefits are received in the form of dividends and/or capital gains.
Deriva@ve Securi@es Value of the security depends directly on, or is derived from, the value of another asset.
Two main types of deriva@ves Forwards
Op@ons
Investment Risk
Investment risks Market risk
Credit risk
Opera@onal risk
Market Risk Results from unexpected movements of general market prices include: 1. 2. 3. 4. 5.
Interest rate risk. Equity risk. Exchange rate risk. Commodity risk. Market liquidity risk.
Credit Risk Risk that a counterparty will default on its obliga@on or the risk that the creditworthiness will change. It includes: 1. Default risk. 2. Credit migra@on risk.
Opera@onal Risk The least-‐well defined of all types of risk. It is in fact an umbrella term for all investment risks other than market risk and credit risk.
(1) Micro and Macro Organiza@on
2 SECURITY MARKETS
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Security Markets Are designed to allow corpora@ons and governments to raise new funds and to allow investors to execute their buying and selling orders.
Primary and Secondary Security Markets Primary Market Secondary Market Where corporate and Where previously government en@@es can issued securi@es are raise capital traded among investors. In short: All securi@es are first traded in the primary market, and the secondary market provides liquidity for these securi@es.
Reasons Why Security Markets are Constantly Evolving Compe@@on • • • • •
Alliances. Entries. Exits. Mergers. Acquisi@ons.
Technological Innova@on • Online brokers. • Electronic Exchanges. • ECNs.
Ini@al Public Offering (‘Going Public’)
If a company’s share is traded in the primary market for the first @me this is referred to as an ini@al public offering.
The Secondary Market • Generally, individual investors do not have access to secondary markets. • They employ security brokers to act as intermediaries for them. • The broker in turn delivers an order to a market place, where the orders are executed. • Finally, clearing and seGlement processes ensure that both sides to these transac@ons honour their commitment.
Types of Orders • Market order. • Limit order. • Not-‐held order. • Stop order. All orders are day orders unless otherwise specified.
Types of Brokers • Discount broker. • Full service broker. • Online broker.
Types of Market Places • Organized security exchanges. • Over-‐the-‐counter markets. • Upstairs markets. • Alterna@ve trading systems. These include: -‐ Electronic Communica@on Networks (ECNs). -‐ Crossing Networks.
Types of Trading Systems • Dealer system. • Auc@on market. • Hybrid market. All market places use one of the first two systems or a mixture (hybrid market).
Market Microstructure The actual mechanisms in a security market that facilitate trading are known as market microstructure. They are the basic features of all the security markets that facilitate trading today.
Market microstructure Transac@on costs Liquidity Anonymity Con@nuity Execu@on Quality Price Discovery Transparency
Two generic organiza@ons • Price driven markets : – Liquidity is provided by “market makers” or “specialists” who have the obliga@on of constantly offering prices for buys and sells – NYSE
• Order driven markets : – Liquidity is directly entered in the market by investors (through their broker) in pos@ng their orders – No intermediary and con@nuous orders/price arrival
• Mixed structures are frequent 28
Orders • Minimum specifica@ons:
– A direc@on (buy or sell, a.k.a bid or ask) – A quan@ty – Eventually a reserva*on price – Execu@on modali@es (@me validity, visible quan@@es, thresholds…)
• Several order types:
– Limit order, market order – Iceberg – Stop, Stop limit, PEG orders
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Matching mechanism • Con@nuous double auc@on – Electronic, automated book. Floor trading is not rare, except for deriva@ves
• Call markets (Fixing Mechanism) – Pre-‐opening and closing call auc@ons in con@nuous markets
• Mixed structures (opening and closing fixings + CDA) 30
Exemple
Price =>
Price (€)
Buy Orders
=> Sum
Sell Orders
=> Sum
95 94 92 90 85 80 77 75
25 50 100 100 100 200 200 100
25 75 175 275 375 575 775 875
100 500 350 200 50 25
1225 1125 625 275 75 25
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Price motions when CDA is implemented Cotation continue 1005
1005
1004 1003
1003
prix
1002 1001
1001 1000
1000
1000
Best A
1000
Best B 999
999 998
998
997
997 996
Prix'
997
996
995 1 2 3 4 5 6 7 8 9 1011121314151617181920212223242526
temps
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BNP-‐PARIBAS (May, 31, 2010)
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A Market Simula@on (with ZIT) • Ar@ficial Stock Market • Based on so[ware engineering techniques and Ar@ficial Intelligence • 3 main components – Market Microstructure (closely related to the one of EURONEXT) – Agents with a specific behavior (here ZIT) – Informa@on (macro economic linkage)
• A useful tool for academic research, but also for technological-‐oriented works • htp://atom.univ-‐lille1.fr 34
Main financial markets in the world
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Remarks • A large part of financial trades occur on OTC markets (80% of deriva@ves for example) • Two important trends – Liquidity frac@oning through a set of electronic networks and plaworms (see next slide) – Algo trading and HFT now play a central role
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A fragmented picture ! (Europe) ORDER
pre-‐ and post-‐trade transparency requirements
Regulated Markets LSE EURONEXT-‐NYSE DB … Mul8lateral Trading Facili8es (MTF): electronic systems controlled by approved market operators or large investment banks. Based on so[ware to pair buyers with sellers.
Internaliza8on (Market Makers): Banks can match orders with other orders on its own book. Price must be shown previous to the deal. Credit Suisse UBS
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• In certain situa@ons, trades can be undergone without pre and post processing transparency… this is the playground for « dark pools »
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Dark pools • Provide liquidity that is not displayed on order books. • Useful for traders who wish to move large numbers of shares without revealing themselves to the open market. Exemples: Baïkal (2009, merged in with Turquoise), promoted by LSE BATS Europe Dark Pool (2009) Blink (2009, promoted by Cheuvreux) Chi-‐Delta (2009, Chi-‐X) Neuro Dark (2009, NASDAQ) SmartPool (2009, NYSE Euronext) Turquoise (2008, 9 commercial banks BNP Paribas, Morgan Stanley, UBS…)
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